From the December 2008 issue of Research Magazine • Subscribe!

December 1, 2008

Financials: Close to Bottoming?

Congratulations to Citigroup's executive management for convincing the U.S. government to give it $20 billion in fresh capital and guaranteeing $306 billion in toxic assets. Mission accomplished!

Think about it: Pandit's Citi gang was able to accomplish what the gang at Bear Stearns and Lehman Brothers couldn't do. Good thing too. Citigroup was on the verge of becoming Citi Bear Brothers Group.

With more than 200 million customer accounts in over 100 countries and a prestigious roster of Blue Chip shareholders, Citigroup has long been considered one of the leaders within the financial sector. But as we're now learning, it's become another kind of leader: A loss leader. Look no further than the devastating multi-billion losses that have annihilated Citi's stock price and frustrated shareholders.

But let's not scapegoat Citi. The entire financial sector is in the midst of an epic shakeout where other breathtaking casualties nobody thought were possible will happen. The end is not yet near.

The financial sector consists of companies involved in commercial and retail banking, investment brokerage, insurance, and specialty finance. Key ETFs following this sector are the Financial Select Sector SPDR (XLF), the iShares Dow Jones U.S. Financial (IYF), the SPDR KBW Bank ETF(KBE) and the Vanguard Financials ETF (VFH). So far this year, financial ETFs have lost between 50-65% of their value.

According to SEC disclosures ending September 30, billionaire investor Nelson Peltz held puts on the SPDRs (SPY) along with a position in the UltraShort ProShares Financials (SKF). Both investment strategies are designed to increase in value when stocks fall.

At the opposite spectrum, are a handful of mutual funds that haven't lost faith in financial shares.

Since the beginning of the year, the Legg Mason Value Trust (LMVTX) has cratered 63.66 percent and the Third Avenue Value Fund (TAVFX) has fallen 53.09 percent. Both funds are really closet sector funds with concentrated holdings in financial stocks.

After the dust settles, which by the way, we're no where close to being, the whole financial sector will be swimming with a lead anchor around its neck that says, "government rules and regulations." This will most likely not be good for capital growth or corporate profits. In other words, the trouble for financials could just be starting.

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Ron DeLegge is the San Diego-based editor of www.etfguide.com.

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